Arestis (eds ) an assessment of the global impact of the financial crisis (2011)

An Assessment of the Global Impact of the Financial
Crisis


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An Assessment of the
Global Impact of the
Financial Crisis
Edited by

Philip Arestis
Rogério Sobreira
and

José Luis Oreiro


Editorial and selection matter © Philip Arestis, Rogério Sobreira and José Luis
Oreiro 2011
Individual chapters © Contributors 2011
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work in accordance with the Copyright, Designs and Patents Act 1988.
First published 2011 by
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Library of Congress Cataloging-in-Publication Data
An assessment of the global impact of the financial crisis / edited by Philip
Arestis, Rogério Sobreira, and José Luis Oreiro.
p. cm.
ISBN 978–0–230–27160–9 (alk. paper)
1. Global Financial Crisis, 2008–2009. 2. Economic history—21st century.
3. Globalization—Economic aspects. I. Arestis, Philip,
1941– II. Sobreira, Rogério. III. Oreiro, José Luis. IV. Title.
HB3722.A87 2010
330.9'0511—dc22

2010033937
10 9 8 7 6 5 4 3
2 1
20 19 18 17 16 15 14 13 12 11
Printed and bound in Great Britain by
CPI Antony Rowe, Chippenham and Eastbourne


Contents
List of Tables and Figures

vii

Notes on the Contributors

xi

1 Introduction
Philip Arestis, Rogério

1

2 Current Crisis in the US and Economic Policy
Implications
Philip Arestis and Elias Karakitsos

12

3 The Global Economic and Financial Crisis: Which
Way Forward?

Ajit Singh and Ann Zammit

36

4 Crises and the Bretton Woods Institutions and the
Crises of the Bretton Woods Institutions
Howard Stein

60

5 Crisis in the Euro Zone
Jonathan Perraton

84

6 The Impact of the Current Crisis on Emerging Market
and Developing Countries
Jesus Ferreiro and Felipe Serrano

108

7 The Crisis in Western and Eastern EU: Does the Policy
Reaction Address its Origins?
Özlem Onaran

135

8 The Impact of the Subprime Financial Crisis on
the Transition and Central Asian Economies:
Causes and Consequences

Nigel F.B. Allington and John S.L. McCombie

159

9 The World Financial Crisis and the Implications for
China
Shujie Yao and Jing Zhang

182

10 The 2008 Financial Crisis and Banking Regulation in
Brazil
Luiz Fernando de Paula and Rogério Sobreira

209

v


vi Contents

11 Exchange-Rate Derivatives, Financial Fragility and Monetary
Policy in Brazil during the World Financial Crisis
José Luis Oreiro and Flavio Basilio

236

Index

261

List of Tables and Figures
Tables
1.1
3.1

Current account surplus as a share of GDP (selected
countries, 2007–2009)

2

Summary table of the causes of the economic and
financial crisis

39

Current account balances (selected economies),
2000–2004

41

Fiscal stimulus to address the global financial and
economic crisis

46

Growth of world output and that of selected countries
and regions, 1991–2007 (% per annum)

48

3.5

Explaining the productivity surge in the US

49

4.1

IBRD and IDA lending, 1998–2009 (US$ million)

62

4.2

IMF resources, disbursements, repayments, income
and outstanding credit (billions SDRs), 1998–2010

63

5.1

Real GDP growth in the euro area

85

5.2

Unemployment rates in the euro area

86

5.3

External position of PIGS, end-2009

102

6.1

Distribution of goods exports depending on the
destination (% total exports)

117

Distribution of the imports of goods by destination
(% total imports)

119

Average annual growth in GDP, employment,
productivity, and real wage, 1991–2009, Selected
Western EU MS

141

7.2

Average annual growth in GDP, employment,

productivity, and real wage, 1989–2009 and
sub–periods, Eastern EU MS

149

8.1

Growth of real GDP: Transition economies
(annual percentage growth rates)

161

3.2
3.3
3.4

6.2
7.1

vii


viii List of Tables and Figures

8.2

Current account balances: transition economies
(percentage of GDP)

164

Growth of real GDP: Central Asian economies
(annual percentage growth)

175

9.1

Evolution of the financial crisis

187

9.2

AIG and the RBS Group

191

9.3

Percentage changes in industrial production

192

9.4

Stock market prices (close price adjusted for dividends
and splits)

196

9.5

China’s economy in the first half of 2009

200

9.6

Regional comparison, 2008–2009

8.3

203

10.1 Mergers and acquisitions with incentives of PROER

214

10.2 Privatisation of state-owned banks

215

10.3 Basel ratio in selected countries (%)

217

10.4 Banks’ portfolio (percentage share)

219

10.5 Market share by shareholder control (in percentage of
total assets)

221

10.6 Return on equity (%)

223

Figures
2.1

UK wages as a percentage of GDP

14

2.2

UK wages relative to productivity

14

2.3

Percentage deviation of real wage rate from productivity
(January 1968 = 100) and unemployment

15

2.4

Compensation of employees and its components

16

2.5

US profits as a percentage of GDP

17

4.1

IBRD and IDA lending trends, fiscal 1970–2000

61

5.1

Headline interest rates

88

5.2

Net household savings rates (% disposable income)

94

5.3

Peak-to-trough decline in output

5.4

Peak-to-trough changes in unemployment

100

6.1

Annual rates of real economic growth (%)

110

99


List of Tables and Figures

6.2

ix

Growth rate in developed economies and difference
between economic growth of developing economies
with regard to developed economies

110

6.3

Economic growth rate (%)

112

6.4

Growth gap between developing economies and
developed economies

113

6.5

Economic growth rates (%) in the period 2003–2010

114

6.6

Annual growth rates (%) of developed economies and
current account balance of developing economies
(in %GDP)

116

Balance on goods and services US–China and nominal
exchange rate of renminbi

121

Balance on goods and services USA–Euro zone and
nominal exchange rate of renminbi

122

7.1

Adjusted wage share, selected Western EU MS

140

7.2

Adjusted wage share, Eastern EU MS

150

9.1

Asymmetric reaction to gains and losses

184

9.2

Evolution of market bubbles, crisis and recovery

185

9.3

Monthly indices of primary commodity prices,
2007–2009

190

Housing price change in the US and the UK,
2005Q1–2009Q1

193

Nominal GDP of top five economies ($ billion)

202

6.7
6.8

9.4
9.5

10.1 Total credit-to-GDP

211

10.2 Number of banks

215

10.3 Bank spread (%)

220

10.4 Portfolio investments in 2008–2009

224

10.5 Real effective exchange rate (1994 = 100)

226

10.6 Domestic credit-over-GDP (%)

228

10.7 GDP growth in 2007–2009

229

10.8 Contribution to GDP growth in 2007–2009

229

11.1 Amounts outstanding of over-the-counter (OTC)
derivatives in billions of US dollars

240

x

List of Tables and Figures

11.2 Effective and equilibrium values of the real exchange
rate (indexed – average value of 2000 = 100)

245

11.3 Nominal exchange rate and currency surplus/deficit
form September 2008 to March 2009

246

11.4 Evolution of banking spread – genreal (% p.y)

247

11.5 Evolution of international reserves

249

11.6 Percentage change (p.m) of reserve requirements and
banking reserves in Brazil (2008.01–2009.01)

249

11.7 Percentage change of industrial output (compared

to the same month in 2007)

250

11.8 Evolution of the international prices of five
commodities (2007/12–2008/12)

251

11.9 Causality diagram

254


Notes on the Contributors
Nigel F.B. Allington, Cambridge Centre for Economic and Public Policy
and Bye Fellow and Director of Studies in Economics, Downing College,
Cambridge University; Professor of Finance, Ecole de Management,
Grenoble; Research Fellow Julian Hodge Applied Macroeconomics
Research Group, Cardiff University. He is a member of the Conservative
Party’s Higher Education Committee and has published on European
issues more particularly price and growth convergence, including ‘One
Market, One Money and One Price’ in the International Journal of Central
Banking, as well on gender wage differences and the economics of higher
education. He is engaged on a major project to measure the efficiency
of UK politicians which is yielding a series of journal articles that
will be published as a single volume in due course. The most recent
article is ‘Moats, Duck Houses and Bath Plugs: Members of Parliament,
the Expenses Scandal and the Use of Web Sites’, forthcoming in
Parliamentary Affairs.

Philip Arestis, Cambridge Centre for Economics and Public Policy,
Department of Land Economy, University of Cambridge, UK; Professor
of Economics, Department of Applied Economics V, Universidad del País
Vasco, Spain; Distinguished Adjunct Professor of Economics, Department
of Economics, University of Utah, US; Senior Scholar, Levy Economics
Institute, New York, US; Visiting Professor, Leeds Business School,
University of Leeds, UK; Professorial Research Associate, Department
of Finance and Management Studies, School of Oriental and African
Studies (SOAS), University of London, UK; and current holder of the
British Hispanic Foundation ‘Queen Victoria Eugenia’ British Hispanic
Chair of Doctoral Studies. He is Chief Academic Adviser to the UK
Government Economic Service (GES) on Professional Developments in
Economics. He has published as sole author or editor, as well as co-author
and co-editor, a number of books, contributed in the form of invited
chapters to numerous books, produced research reports for research
institutes, and has published widely in academic journals.
Flavio Basilio is Assistant Professor of Economics at Universidade de
Brasilia (UnB), Risk Management Assessor at Banco do Brasil (BB) and
Member of the Brazilian Keynesian Association (AKB). He has published
various articles in academic journals in Brazil.
xi


xii Notes on the Contributors

Luiz Fernando de Paula is Associate Professor of Economics, University
of the State of Rio de Janeiro (UERJ) and CNPq Researcher. He is currently
President of the Brazilian Keynesian Association (AKB) and member of
the editorial board for the Brazilian Journal of Political Economy. His publications include more than 70 articles on banking, financial fragility,
economic policy, Post Keynesian theory, and the Brazilian economy in

books and scientific journals, such as the Cambridge Journal of Economics,
the Journal of Post Keynesian Economics, Banca Nazionale del Lavoro
Quarterly Review, CEPAL Review, and the Brazilian Journal of Political
Economy. He has also authored or co-edited ten books, including
Monetary Union in South America: Lessons from EMU (2004) and Financial
Liberalization and Economic Performance in Emerging Countries (Palgrave
Macmillan, 2008).
Jesus Ferreiro is Associate Professor in Economics at the University
of the Basque Country, in Bilbao, Spain, and an Associate Member of
the Centre for Economic and Public Policy, University of Cambridge.
His research interests are in the areas of macroeconomic policy, labour
market and international financial flows. He has published a number of
articles on those topics in edited books and in refereed journals such as
the American Journal of Economics and Sociology, Economic and Industrial
Democracy, Économie Appliquée, Ekonomia, European Planning Studies, the
International Journal of Political Economy, the International Labour Review,
the International Review of Applied Economics, and the Journal of Post
Keynesian Economics.
Elias Karakitsos is Director of Guildhall Asset Management; chairman
of Global Economic Research; and an Associate Member of the Centre
for Economic and Public Policy, University of Cambridge. He was a
Professor at Imperial College, Head of Economics for ten years and has
acted as an advisor to governments and financial institutions, including Citibank, Oppenheimer, Allianz, Crédit Agricole and Standard
Chartered. He is the author of five books/monographs, 90 papers in
learned journals and more than 330 reports on financial markets.
John S.L. McCombie, Director, Cambridge Centre for Economic and
Public Policy, Department of Land Economy, UK; Fellow and Director of
Studies in Economics, Downing College, Cambridge; Director of Studies
in Land Economy, Downing College, Christ’s College and Girton College;
Member, Centre for Globalisation Research, Queen Mary, University of

London. He did both his undergraduate degree and his Ph.D. at the
University of Cambridge. He was recently Specialist Advisor to the


Notes on the Contributors xiii

House of Lords and is a consultant to the World Bank and the Asian
Development Bank. He was an editor of Regional Studies and is currently
an editor of Spatial Economic Analysis. He is a co-editor or co-author of
15 books, and the author of over one hundred articles in books and
journals, including the Cambridge Journal of Economics, the Economic
Journal, the Manchester School, Oxford Economic Papers, the Journal of
Regional Science and the Journal of Post Keynesian Economics.
Özlem Onaran is Senior Lecturer at Middlesex University, Britain. She
has formerly worked at the Vienna University of Economics and Business,
Istanbul Technical University, the University of Applied Sciences, Berlin,
and the University of Massachusetts, Amherst, where she is currently
also a research associate at the Political Economy Research Institute.
She has published widely in academic journals and books in the areas
of globalisation, distribution, employment, investment, financial crisis,
development, and gender.
José Luis Oreiro, Associate Professor of Economics at University of
Brasilia (UnB), Level I Researcher at National Scientific Council (CNPq/
Brazil), Director of the Brazilian Keynesian Association (AKB) and
Member of the Editorial Board of the Brazilian Journal of Political Economy
(REP). He has published more than 60 articles in academic journals in
Brazil and other countries, three books as editor and contributed in the
form of invited chapters to many other books. According to REPEC, he
is among the top 10 per cent of academic economists in Brazil.
Jonathan Perraton is Senior Lecturer in the Department of Economics

and associate of the Political Economy Research Centre, University of
Sheffield, UK. He has published invited chapters to book and articles
in academic journals, particularly on economic globalisation, comparative national capitalisms and economic methodology. He is also joint
author (with David Goldblatt, David Held and Anthony McGrew) of
Global Transformations: Politics, Economics and Culture (1999) and coeditor (with Ben Clift) of Where are National Capitalisms Now? (Palgrave
Macmillan, 2004).
Felipe Serrano is Professor in Economics at the University of the Basque
Country, in Bilbao, Spain and head of the Department of Applied
Economics V at the University of the Basque Country. His research
interests are in the areas of social security, the welfare state, labour
market, innovation and economic policy. He is the author of a number
of articles on those topics in edited books and in refereed journals such as
Economies et Sociétés, Ekonomia, European Planning Studies, the Industrial


xiv Notes on the Contributors

and Labor Relations Review, the International Labour Review, the International
Review of Applied Economics and the Journal of Post Keynesian Economics.
Ajit Singh is an Emeritus Professor of Economics at Cambridge
University and Life Fellow of Queen’s College. Since his retirement
he has been appointed as a Senior Research Fellow at the Judge’s
School of Management at Cambridge. He is an author of 15 books and
monographs and about 200 academic articles. Nearly a hundred of the
latter have been published in refereed professional economic journals
including the topmost ones. He has been a senior economic advisor to
the governments of Mexico and Tanzania, working with the highest
levels of government. He was elected as an academician of the British
Academy of Social Sciences in 2004. In 2006 he was inducted into
the Hall of Fame of the Economics Department at Howard University

where he did his Master’s Degree before goining on to do a Ph.D at
the University of California, Berkeley. His main research interests are:
(i) the theory of the firm, the stock market, corporate governance, corporate finance, take overs and mergers and the market for corporate control;
(ii) de-industrialisation and structural change in advanced countries;
globalisation employment and productivity in advanced and developing
countries; and (iii) the industrial revolution of the third world and
economic policy in emerging economies.
Rogério Sobreira, Associate Professor of Economics and Finance,
Brazilian School of Public and Business Administration at Getulio
Vargas Foundation and CNPq Researcher. He has published several
articles in academic journals and invited chapters mainly on banking
regulation, banking firms, investment financing and public debt management. He has co-edited five books, all in Portuguese: Financial and
Banking Regulation, Development and the Building of a Nation – Economic
Policy, Development and the Building of a Nation – Public Policy, Fiscal
Adjustment: The Case of Selected Countries and Monetary Policy, Central
Banks and Inflation Targeting. He is member of the Brazilian Keynesian
Association.
Howard Stein is a Professor in the Center for Afroamerican and African
Studies and also teaches in the Department of Epidemiology at the
University of Michigan. He is a development economist, educated in
Canada, the US and the UK, who has taught in Asia and Africa. He is the
editor or author of more than 15 books and collections. His research has
focused on foreign aid, finance and development, structural adjustment,
health and development, industrial policy and rural property right


Notes on the Contributors xv

transformation. His latest authored book is entitled Beyond the World
Bank Agenda: An Institutional Approach to Development (2008). The book

examines the evolution of the World Bank agenda aimed at explaining
the failure of these policies in places like sub-Saharan Africa. The volume
also generates alternatives based on institutional economic theory and
applies them in the areas of state formation, financial development
and health care.
Shujie Yao is Professor and Head of the School of Contemporary Chinese
Studies at the University of Nottingham. Before joining Nottingham
as Professor of Economics and Chinese Sustainable Development, he
worked at the University of Oxford, Portsmouth and Middlesex as
research fellow, lecturer, Professor and Chair of Economics. Professor
Yao is an expert on economic development in China. He has published
six research monographs, edited books, as well as produced more than
70 refereed journal articles. He was ranked eighth among the world’s
China scholars specialising in the study of the Chinese economy in
a recent article published in the Journal of Asian Economic Literature.
He is founding editor of the Journal of Chinese Economic and Business
Studies, chief economics editor of Xi’an Jiaotong University Journal (Social
Sciences), an editorial member of the Journal of Comparative Economics,
Food Policy and the Journal of Contemporary China. Professor Yao is also
coordinator of the China and the World Economy programme at the
Globalisation and Economic Policy Centre at Nottingham and special
chair professor of economics of Xi’an Jioatong University. He has had a
wide range of consultancy experience with major organisations including
the UNDP, FAO, World Bank, ADB, DFID, EU and the UNCDF, working
in many less developed and transitional economies in Africa, Asia and
Eastern Europe.
Ann Zammit’s professional work has included university teaching,
research, economic advisory work, journalism, documentary film
production, and other policy-oriented activities. It involved working for various periods in Turkey, Malta, Chile and elsewhere in Latin
America, and in Eastern Europe. Such work has always focused on

global development issues. She has been employed by various international institutions – the Organization for Economic Co-operation and
Development (OECD), the Organization of American States (OAS), the
UN Research Institute for Social Development (UNRISD) and the South
Centre (an intergovernmental body of developing countries based in
Geneva). Consultancy work has been undertaken for the International
Labour Organization (ILO) and the United Nations Development


xvi Notes on the Contributors

Programme (UNDP). She taught at the University of Chile, the
University of Hull (UK), University College, London, and Ithaca College
(London). Research was undertaken at the Institute of Development
Studies, Sussex and the Latin America Bureau, London. Involved in
establishing the International Broadcasting Trust (an innovative nonprofit TV documentary production company) she contributed to the
development of programme ideas on development issues and produced
the accompanying print-backup. Recent research has focused on three
areas: aspects of corporate governance and corporate social responsibility;
global labour standards and other global employment issues; and
macroeconomics and gender equality.
Jing Zhang is a lecturer at School of Contemporary Chinese Studies in
the University of Nottingham. Jing was awarded a Ph.D. in Economics
from the University of Birmingham. Her research focuses on the
empirical studies of globalisation and the environment; more specifically on the impact of economic growth; foreign direct investment flows
on the environment; the role played by the difference in environmental
regulations in the foreign firm location choice; and the impact of corruption and government quality on foreign investment inflows and on
the environmental regulations. Her current research interests include the
implications of the financial crisis for China amongst others.

1
Introduction
Philip Arestis, Rogério

Recent economic events have had a profound impact on the global
economy. According to the World Bank Economic Outlook published
in April 2010, the major advanced economies experienced a fall of
3.2 per cent of GDP in 2009 and are expected to record a moderate
growth of 2.3 per cent in 2010. The impact of the crisis was stronger
in Japan and euro area than in the United States, the centre of the
financial crisis. Indeed, the US economy experienced a decline of
2.4 per cent in GDP compared to a 4.1 per cent fall in GDP in the euro
area and 5.2 per cent in Japan. The United Kingdom is also projected to
experience a huge fall of 4.9 per cent of GDP in 2010.
These numbers are in sharp contrast to those observed in developing
countries. For instance, the Newly Industrialized Asian Economies
(Korea, Taiwan, Hong Kong and Singapore) had a fall of only 0.9 per cent
of GDP in 2009. For the rest of Asia, the numbers are even better. In the
case of China and India, GDP growth of 6.6 per cent was recorded in
2009, and in 2010 the growth in GDP is expected to be 8.7 per cent.
The ASEAN-5 (Indonesia, Thailand, Philippines, Malaysia and Vietnam)
experienced only modest growth of 1.7 per cent in 2009, but is expected
to have robust growth of 5.4 per cent in 2010. Even in Latin America the
impact of the crisis will be weaker than has been the case in developed
countries: South America and Mexico experienced a fall of only GDP
1.9 per cent in 2009. For 2010, this region is projected to achieve robust
GDP growth of 4.1 per cent.
During the recent crisis the economic performance of developing
countries has been rather curious. In fact, just one decade earlier, the
East Asian Crisis had shown the fragility of the ‘Asian Model’ of growth

compared to the ‘Western Model’ of capitalism. In 1994–95, the Mexico
Crisis had a huge impact on some important Latin American economies,
1


2

Assessing the Global Impact of the Crisis

including Brazil. For a long time Latin America has been considered a
region characterised by balance of payments crises, capital flight and
high rates of inflation. But now things have changed. The 2008 financial
crisis had hit the heart of capitalism, but the effects were much weaker
at the ‘periphery’ of the capitalist system than in its centre. The relevant
question is why.
One possible answer is that developing countries have learned
from previous crises and have adopted policies that help to reduce
their external fragility. Indeed, as can be seen in Table 1.1, developing
countries recorded strong current account surpluses in 2007, one
year before the crisis. This situation did not change significantly in
2008 and 2009. Why would being a capital-exporting country help
to isolate the economy from the effects of a financial crisis abroad?
The answer to this question is that current account surpluses are, in
general, associated with a substantial accumulation of foreign reserves.
This is especially important in avoiding a capital flight from a country
in the face of a fall in exports and in foreign direct investment during
an external crisis. Capital flight can have disruptive effects over a
developing economy since it can produce a huge and sudden devaluation
of nominal exchange rate. In general, this can have negative effects
over the real output of these countries, essentially as a result of the fact

that a significant share of liabilities of private agents and government
are expressed in foreign currency, while their assets are denominated
principally in domestic currency.
Another problem that can arise as a result of capital flight is an
increase in the domestic rate of interest in an attempt by the Central
Table 1.1 Current account surplus as a share of GDP (selected countries,
2007–2009)

United States
Euro area
Japan
United Kingdom
Newly Industrialized Asian
Countries
China and India
ASEAN-5
South America
and Mexico
Source: IMF (2010).

2007

2008

2009

–5.2
0.3
4.8
–2.7

5.7

–4.9
–0.7
3.2
–1.7
4.4

–2.9
–0.6
2.8
–1.3
8.9

7.0
4.9
0.7

5.9
2.6
–0.3

4.1
5.1
–0.3


Philip Arestis, Rogério

3

Bank to avoid a substantial devaluation in the domestic currency. In this
case, monetary policy will be used as a device to achieve an external
balance, but its effect over the domestic economy will be to internalize
the contraction of output occurring abroad by means of a reduction of
domestic demand through interest rate increases. If the fiscal position
of the country affected by a capital flight was not good before the crisis
(for example, the country had a high public debt as a ratio to GDP), the
increase in interest rate by the Central Bank would force the Treasury
to reduce government expenditures in order to achieve or increase a
primary surplus. This would be required to restore the ‘confidence’ of
the financial system in the ability of the government to pay its debt. The
combination of a monetary contraction with a fiscal contraction would
produce a huge fall in domestic demand at the same time that external
demand is falling as a result of the external crisis. The combined result
of domestic and external demand contraction would be a huge fall in
GDP, which will be higher than the one observed in developed economies.
This is so since for the latter, fiscal and monetary policies would be
conducted in order to reduce the output loss caused by the financial
crisis instead of attempting to avoid a capital flight.
This reasoning shows that a current account surplus and the accumulation of foreign reserves are important for developing countries
because they allow them to conduct anti-cyclical policies in the face of a
financial crisis in developed countries. Stabilization of output is important
for a robust growth in the long term due to its effects over capitalist
animal spirits. Developed countries, then, should never pursue a growth
strategy based solely on the accumulation of ‘foreign savings’. This book
presents, therefore, an extensive and widespread analysis of the crisis as
it impacted on both developed and developing countries. It will show
that the impact of this crisis is far from being homogenous in both the
developed and the developing world. The most intriguing aspect of this

crisis is the fact that the crisis had less of an impact on those economies
responsible for the generation of the ‘global savings glut’, and more on
those economies that are more dependent on foreign capital inflows.
In connection with this aspect, the book also addresses the question of
why this crisis has been so limited in magnitude and of such relatively
short duration. Finally, it is shown that financial liberalisation alone
cannot provide a full explanation of the crisis. It is necessary to take a
good look at the size of the global financial sector and also to its related
redistributive impact. Thus, one of the main lessons that can be learned
from this volume is a profound need to implement policies that can
guarantee financial stability.


4

Assessing the Global Impact of the Crisis

In chapter 2 Philip Arestis and Elias Karakitsos continue the discussion by considering the origins of the current crisis along with policy
implications. They concentrate on the US experience but also comment
on the experiences in other countries. The focus of this chapter is on
the emphasis attributed to the ‘efficient market hypothesis’ that all
unfettered markets clear continously thereby making disequilibria,
such as bubbles, highly unlikely. Indeed in this view, economic policy
designed to eliminate bubbles would lead to ‘financial repression’, a
very bad outcome in this view. Since the early 1970s when governments
attempted and succeeded in implementing financial liberalisation initiatives, especially in the US and the UK, the focus has been on creating
markets completely free from any policy interference. This is based on
the belief that liberalised financial markets are very innovative, and
sure enough they were. The experience with financial liberalisation is
that it caused a number of deep financial crises and problems that were

unprecedented in terms of their depth and frequency. However, most
important for the purposes of this chapter, it was the US experience of
financial liberalisation that is most telling in terms of the causes of the
current crisis. Financial liberalisation alone cannot provide a full explanation of the crisis. The size of the financial sector is also of relevance.
In this respect, it is important to note the enormous redistribution that
had taken place in the countries at the centre of the crisis. For it was the
case that a significant redistribution from wage earners to the financial
sector had materialised prior to August 2007. Over the period prior to the
‘Great Recession’ and after the intense period of financial liberalisation,
especially in the US, great strides were seen in terms of the development
and extension of new forms of securitisation and the use of derivatives.
This was a practice which led to the growth of collateralised debt instruments, especially in particular, in the form of collateralised mortgages.
This financial architecture, along with the redistribution and the financial
liberalisation alluded to above, were the main causes of the crisis. But
there were, the chapter argues, contributory factors. Two of them are
emphasized: the international imbalances, resulting principally from
the growth of the Chinese economy, and the monetary policy pursued by
countries over the period leading to the crisis. The chapter also discusses
the clear policy implications that emanate from the crisis. It is concluded
that one important policy that has not been addressed properly in
recent discussions is that of financial stability.
Ajit Singh and Ann Zammit, in chapter 3, address the following main
analytical questions concerning the global impact of the financial crisis:
why has its impact been so limited in magnitude and of such relatively


Philip Arestis, Rogério

5

short duration. The world economy was hit by unprecedented shocks
in the period leading up to the crisis. The financial system was the
biggest casualty and seemed to be on the verge of a meltdown. This
was due to the fall of the Lehman Brothers, to the dangerously high
debt–equity ratio of the leading players in the financial market, and to
the credit crunch indication that the banks were mutually suspicious.
The securitisation of the subprime mortgage loans, together with financial
globalisation, led to the worldwide financial crisis. In view of the uncertainty concerning the contamination caused by subprime mortgages
in the securitised assets of most major financial institutions, the market
value was no longer an accurate guide to asset prices. Individually and
collectively, these shocks to the global economy were both quantitatively
huge and qualitatively unprecedented. It was for these reasons that
many students of the world economy expected the impact of the 2008
financial crisis to be quite severe, approaching the levels of the Great
Depression of 1929. However, fortunately for the world economy this
kind of outcome has not occurred to date. The highest recorded fall
in advanced countries’ GDP growth for a 12-month period during the
Great Depression was 30 per cent in the US. Most countries rich and
poor have escaped such catastrophic contractions in GDP; this is not
an accident, since there are a number of positive long-term structural
factors at work in the world economy, which have not been given
adequate attention by commentators either at the time of the crisis or
subsequently. These factors are: (a) the highly positive role of emerging countries in the world economy; (b) the unexpected co-operation
between countries, which has taken place during this crisis and which
stands in striking contrast to the ‘beggar your neighbour’ policies
followed by nation-states in the 1930s; and (c) the political economy
of the governance of the crisis which has meant that there has been
coherence at the top level in the formulation and execution of economic
policy. Despite the progress made so far (for example, saving the
financial system from a meltdown) the world economy is still not out

of the woods. The challenge is to create a new financial system, which
maintains the dynamism of the old system while protecting the world
economy from frequent bubbles, often caused by unwarranted euphoria
or undeserved pessimism.
In chapter 4, Howard Stein argues that, in 2007, the IMF faced a ‘crisis
of identity’ and huge cutbacks in spending. Lending from its General
Resource Account (GRA), its major source of income, fell by an unprecedented 91 per cent from its peak in 2003 to a mere $6 billion – a level not
seen since the 1970s. Similarly the International Bank for Reconstruction


6

Assessing the Global Impact of the Crisis

and Development (IBRD) saw its loans plummet by 40 per cent. In both
cases middle-income countries were able to secure alternative sources of
financing without any neoliberal baggage. This, many argued, helped
to contribute to the global economic crisis. Like a phoenix rising from
the ashes, the current crisis has resurrected the World Bank and the
IMF. The Fund, for example, lent nearly $55 billion alone to European
countries between November and April 2009 and another $78 billion
since the creation of its Flexible Credit Line in March 2009. At the G20
meeting in early April 2009, the IMF received authority to triple its
lending capacity to $750 billion and to expand its SDR allocation by
an additional $250 billion. China and some other countries have gone
further and talked of creating a new global currency based on SDRs
administered by the Fund. At the same time, the IMF now claims that
it has reformed its ways and made a greater commitment to regulation,
counter-cyclical monetary and fiscal policy, social safety nets for the
poor and moved towards ex ante from ex post conditionality. The chapter

investigates these claims and whether the IMF and World Bank are part
of the problem or the solution to the global economic crisis as it has
affected developing countries.
In chapter 5 by Jonathan Perraton there is a discussion of the impact
of the crisis in the euro area. In much comment the euro area has been
perceived as being relatively insulated from the current crisis. Ireland
and Spain apart, the member countries of the euro area typically did not
experience house price booms comparable to those observed in the US
and the UK. Indeed, the member countries financial systems were less
Anglo-Saxon in character and were therefore assumed to be less vulnerable to a financial crisis. Externally, the euro area is in broad balance,
with Germany in surplus and most trade conducted within the area
itself. The European Central Bank (ECB), in particular, has been keen
to portray the euro area as an ‘innocent bystander’ affected by problems
generated elsewhere. This chapter provides a critical evaluation of
these claims, examines the evolution of imbalances in key economies
and assesses the performance of the macroeconomic framework of
the ECB and the Stability and Growth Pact in response to the crisis.
After reviewing macroeconomic developments, the chapter argues
that significant imbalances had emerged in euro-area economies, with
Germany being a major contributor to global payments imbalances and
asset price bubbles emerging elsewhere. This has created stresses within
the zone that the current macroeconomic policy framework has
struggled to ameliorate. The official emphasis on supply-side measures,
particularly labour market flexibility, has not succeeded in improving


Philip Arestis, Rogério

7

macroeconomic performance in the euro area. Indeed, wage increases
running persistently below productivity growth in Germany and elsewhere may have aggravated imbalances. The euro-area macroeconomic
framework has been sorely tested in the current crisis. Indeed, it may
have limited the ability of the euro area to ensure coordinated reflation
and the moves to restore ‘business as usual’ in the euro area macroeconomic policy framework risk stifling any recovery.
The impact of the crisis over developing countries is analysed by Jesus
Ferreiro and Felipe Serrano in chapter 6. Although for the mainstream
economic theory, developing countries are net importers of foreign
capital, recent experience shows that they have become net capital
exporters. This change of behaviour has given rise to the phenomenon
known as ‘global imbalance’, a combination of two main elements: the
deficit in the US balance of payments and the surplus in the balance of
payments of developing economies. However, this interpretation hides
the fact that the surpluses in the balance of payments are generated in
only a small number of economies – more precisely, in raw material
exporter countries and in some emerging Asian economies. The rest
of the developing countries continue to be net importers of capital
resources, and, consequently, they depend for their development and
growth on the inflow of foreign capital. The aim of this contribution is
to analyse the impact of the current financial and economic crisis on
developing countries. The authors pay special attention to the recent
evolution of capital inflows in developing countries. This analysis
will be made for the different ‘regions’ of developing countries. The
idea is that the crisis is having a smaller effect on those economies
responsible for the generation of the ‘global savings glut’, and more
impact on those economies, like the countries of Eastern Europe or
Latin America, that are more dependent on foreign capital inflows.
The analysis focuses principally on two kinds of capital flows: foreign
direct investment inflows, and capital inflows emanating from banks
in developed economies.

In chapter 7, Özlem Onaran discusses the effects of the current global
crisis on Western and Eastern Europe, and reviews the policy reaction to
the crisis. The main thesis of the chapter is that the decline in the labour
share across the globe has been a major factor leading to the current
global crisis. The chapter argues that global imbalances should also be
interpreted in connection with the distributional crisis. The debt-led
consumption-based growth of the US economy was financed by the
surpluses of countries like Germany in Europe in addition to Japan or
developing countries like China and South Korea, and the oil-rich


8

Assessing the Global Impact of the Crisis

Middle Eastern countries. In Germany, current account surpluses and
the consequent capital outflows to the US were made possible by wage
moderation, which has suppressed domestic consumption and fuelled
exports. Wage moderation in Germany created further imbalances within
the West as well as between the East and the West. Thus, the high current
account surpluses of the neo-mercantilists of the EU, i.e. Germany along
with Austria, Netherlands, and Finland develop simultaneously with
widening trade deficits in the other western EU countries like Spain,
Greece, Portugal, Italy and Ireland. The low level of wages in Eastern
Europe also did not save them from running high current account deficits
thanks to the high level of imports from the international supplier
networks of the European multinational companies as well as the high
profits of these foreign investors (repatriated as well as reinvested). The
fundamental problem of Eastern Europe was an excessive dependency on
foreign capital flows in the absence of a development strategy backed by

industrial policy, and as a typical consequence of this dependency a bust
episode following the boom was an unavoidable outcome of reversals
in capital flows. The mainstream policy reaction to the crisis has simply
been efforts to return to the ‘business as usual’ strategy of neoliberalism.
There is a clear unwillingness to address the distributional aspect of the
origins of the crisis as well as the distribution of the burden of the costs
of the crisis. The chapter concludes by discussing policy alternatives
to this mainstream position.
In chapter 8 Nigel Allington and John McCombie reconsider the
‘successes’ of the Transition Economies, including those that entered
the European Union (EU) in 2004, following the fall of Communism in
1989, namely the T8. It is now twenty years since the T8 became market
economies and ten years since they entered the EU. Following the initial
economic dislocation that occurred as these economies moved to a
market economy, they experienced rapid growth until the 2007 crisis.
The enhanced globalisation of capital flows, market liberalisation, and
technology transfer that raised the levels of economic growth in the T8
is shown to have generated a considerable degree of convergence since
2004. The other transition economies in Central Asia had ten years
of negative or slow growth until 2000 when their growth accelerated
substantially. The T8 economies have now experienced a substantial
economic collapse as an indirect result of the subprime crisis, whereas
the other transition economies, with the exception of Kazakhstan, have
not fared so badly. This chapter attempts to answer the question of
whether for the T8 countries it is the transition process per se, or simply
the transition economies that are in crisis. In other words, the question